Nicholas Hartney EA Blog Nicholas Hartney, Licensed to Represent Taxpayers before the IRS | Snapshot of Current Tax Issues| Genesis Tax Consultants, LLC
Genesis Tax Consultants

Nick's Tax Snapshots

Nicholas Hartney, Licensed to Represent Taxpayers before the IRS | Snapshots of Current Tax Issues

How IRA Contributions Work for U.S. Expats | How Foreign Earned Income Affects your IRA Contribution Limits.

U.S. expatriates may be able to set money aside in an IRA, however, you need to be aware of some technical rules that call for close scrutiny to make sure that your savings achieve the maximum tax savings. In particular, the foreign earned income exclusion coordinates with the rules for IRA eligibility, and this creates a very narrow range of options for American expats who are living and working abroad.

The Foreign Earned Income and Foreign Housing Exclusions

Most U.S. expats who live and work abroad qualify for the foreign earned income exclusion, which provides that the first $102,100 (for 2017 and $104,100 2018) of foreign wages or self-employed income is excluded from U.S. federal income taxes.

Expatriates are also eligible for the foreign housing exclusion, which amount depends on their location.

Effect of Excluded Income on IRAs

Any income that is excluded from income taxes as a result of either of these two tax breaks is considered income which cannot be contributed to an individual retirement account. Any income that is not excluded from the tax can potentially be contributed to an IRA, however. 

Coordinating the Foreign Earned Income Exclusion With Roth IRAs

Roth IRAs have income limitations. A single taxpayer is eligible to fund a Roth IRA up to the full contribution limit if his modified adjusted gross income is under $118,000 as of 2017. The amount that can be contributed to a Roth is gradually reduced for a single filer whose income falls between $118,000 and $133,000. No Roth IRA contribution is allowed if your MAGI is more than $133,000.

For Roth IRA purposes, a taxpayer's adjusted gross income is modified to add back any foreign earned income exclusion and/or foreign housing exclusion that he may have claimed. This creates a very narrow range of income possibilities for funding a Roth IRA if you live and work abroad. A single filer claiming the full $102,100 for 2017 or $104,100 2018, the foreign earned income exclusion would have to have foreign wages over $102,100 ($104,100 in 2018) and modified adjusted gross income not more than $133,000 to be eligible to contribute some funds to a Roth IRA, and this is a somewhat narrow range.

Coordinating the Foreign Earned Income Exclusion With Traditional IRAs

Traditional IRAs are coordinated with the foreign exclusion in two separate ways. First, like the Roth IRA, a person cannot contribute excluded income to a traditional IRA. Second, a deduction for a traditional IRA contribution might be limited or eliminated entirely if the person is covered by their employer's retirement plan. In the case where a taxpayer is not eligible to participate in a group retirement plan, a traditional IRA would be available only on foreign wages or net self-employed income in excess of the foreign earned income exclusion amount.

Paid Income Taxes to a Foreign Government? Use the Foreign Tax Credit Instead 

American expatriates working overseas may find that utilizing the foreign tax credit (FTC) might yield more advantageous results than the foreign earned income exclusion in certain situations. If you claim the foreign tax credit, you will have either taxable wages or net self-employment income that will provide you with an opportunity to fund either a Traditional or Roth IRA. The FTC also provides a tax reduction in the U.S. based on taxes you have paid to your host country. You are taxed on this income so it's not excluded and you are eligible to contribute to either a Traditional or Roth IRA, depending on the amount of foreign income taxes paid.